Thursday, October 18, 2012

How to Set Up an Envelope Budget

The envelope budget, sometimes called the envelope method or system is the practice of managing household expenses through the use of cash envelopes. Dubbed "Grandma's way to handle money" by Dave Ramsey, this depression era method of budgeting is still as effective as ever.

Yes, the modern versions of the envelope budget are readily available online in programs like Mvelopes but they cost money. The focus of this post is on the traditional envelope method which is FREE!

How to set up an envelope budget

Step 1: Tally up actual spending from the previous month

Gather up all your credit card, bank statements, invoices and receipts from the previous month. If you can get two or three months worth of information that is better but one month will do for now. From your statements, invoices and receipts take note of everything you spent money on (i.e. variable expenses only) during that period then add them up into four or five broad categories.

For example, you might add up all the times you bought gas for the month and put it into a category called "Transportation". Any money spent on anything related to transportation goes into that category (this would include things like gas, motor oil, tune ups etc.) You might have another category for "Groceries", every time you spend money at the grocery store it would be added to this category and so on.

This will be the basis of your envelope budget categories.

* Do NOT include fixed payments or expenses in this calculation. Expenses like your mortgage, car payments, utility bills etc should be left out of the budget.

Step 2: Draft and finalize your list of categories

Your envelope categories can be as broad or as narrow as you want, its up to you. If you want many categories you can use the broad categories from step 1 and expand them until you're satisfied you have the right number of categories for your envelopes; on the other hand you might be happy sticking with four or five broad categories for now, you can always add more categories later if you need to. This is not an exact science, just do what feels right.

* It's better to keep it down to just a few categories, your budget will be far easier and less time consuming to manage than if you use a lot of categories (ten or more).

Step 3: Label and fund the envelopes

Now comes the fun part! Label your envelopes and fill them with the cash amounts you calculated in step 1. How often you get paid will dictate how much to put into the envelopes. For example, if you get paid bi-weekly then you will be funding your envelopes every two weeks. The cash in each envelope will have to last until your next pay period.

Step 4: work the envelope system

With your envelope budget now complete, its time for the real test - putting it into practice. You should not expect the perfect budget on the first pass or even the second try. It will take a a lot of trial and error before you finally find the right mix and develop the perfect envelope budget.

Here is one last point to remember as you work the envelope system:

Give it some time - As I mentioned previously, the envelope budgeting system is not perfect or exact but it will work if you give it a chance. It may take you several tries before you finally perfect your budget. the key is to just keep tweaking and changing it until you do get it right.


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